Production Sharing Contract (PSC), first introduced in Indonesia in 1966, is a risk contract for oil companies to access oil and gas resources which are widely used in many oil and gas producing countries. In a PSC system, the state owns all of the oil and gas production, and the oil companies only act as the contractors who provide technical and financial services for exploration and development operations, and in return, the production will be shared between the oil companies and the State according to the provision in the PSC.
In contrast with the PSC system, the other system to access oil and gas resources is called a concession license, which grants property right to natural resources to the oil companies, and excludes the government from any participation in the business, as well as the management of petroleum operation and profits. In return, the state will receive royalty payments on production volume, income taxation, and similar payments from the concessionaire. The relationship between the government and the oil companies makes the position of the parties in the PSC equal to one another, while in contrast, the concessionary system creates a vertical relationship which favors the government as opposed to the oil companies.
As a contractual relationship, the Indonesian PSC system has its own mechanism for income tax. To this extent, this article describes the taxation system in PSC relevant to Indonesian tax regulations. In this matter, PSC is the Lex specialist for Indonesian Income Tax Law, and the Branch Profit Tax Treaty is the Lex specialist of the PSC.
1. First Tranche Petroleum (FTP) and Cost recovery
First Tranche Petroleum (FTP) is the oil and gas shared by the parties in PSC before the cost recovery. Usually the FTP shared is between 10% – 20% of production. The FTP mechanism was applied for the first time in 1988 for Indonesian PSC, and for some oil and gas practitioners, FTP is treated as Quasi-Royalty.
Cost recovery is needed by the contractor to recover the costs of exploration, development and operations out of gross revenue. It is one of the most common features in PSC.
Taxable income in PSC is derived from the net revenue, which is already deducted from the FTP and cost recovery. Similar to the PSC system, in the concession system, taxable income is derived from net revenue which is already deducted from operating costs, depreciation, depletion and amortization (DD&A) and intangible drilling costs (IDCs). These deductions in the concession system can be counted as cost recovery, but the difference with cost recovery in PSC that there is ‘no cost recovery limit’ in the concession system.[1] In the Indonesian PSC system, cost recovery submitted by oil companies is audited by the State Audit Board (BPK) and/or Agency for Finance and Development Supervision (BPKP) and also the Upstream Oil and Gas Supervisory Board (BP MIGAS).
2. Different income tax regulations for different PSC generations
2.1 PSCs signed before the enactment of Income Tax Act 1983
PSCs signed before the enactment of Law No. 7 of 1983, regarding Income Tax (Income Tax Act 1983), are subject to Corporate Tax Ordonantie 1925 and Tax upon Interest, Dividend, and Royalty Act 1970 with all the implementing regulations. Moreover, Minister of Finance Decree No. 267/KMK.012/1978 (KMK 267) also regulates the double layer of taxation which will be further discussed below.
2.2 PSCs signed after the enactment of the Income Tax Act 1983
All the PSCs signed after the enactment of Income Tax Act 1983 are subject to Income Tax Act 1983 and its amendments, consequently by Law No. 7 of 1991, Law No. 10 of 1994 and Law No. 17 of 2000 (Income Tax Acts). Other than that, Minister of Finance Decree No. 458/KMK.012/1984 (KMK 458) is also applicable to the PSCs.
3. Double layer of taxation
The Income Tax Acts uses a mechanism known as effective tax rate which is derived from Branch Profit Tax levied after Corporate Income Tax. Branch Profit Tax, provided in Article 26 (4) of the Income Tax Acts, is an additional income tax upon the net income after tax received by a Permanent Establishment (Badan Usaha Tetap).[2] The normal rate for the Branch Profit Tax in the Income Tax Acts is 20% after the Corporate Income Tax. However, for some countries which have a Branch Profit Tax Treaty with Indonesia, the Branch Profit Tax is below 20%.
In contrast with the PSC system, the other system to access oil and gas resources is called a concession license, which grants property right to natural resources to the oil companies, and excludes the government from any participation in the business, as well as the management of petroleum operation and profits. In return, the state will receive royalty payments on production volume, income taxation, and similar payments from the concessionaire. The relationship between the government and the oil companies makes the position of the parties in the PSC equal to one another, while in contrast, the concessionary system creates a vertical relationship which favors the government as opposed to the oil companies.
As a contractual relationship, the Indonesian PSC system has its own mechanism for income tax. To this extent, this article describes the taxation system in PSC relevant to Indonesian tax regulations. In this matter, PSC is the Lex specialist for Indonesian Income Tax Law, and the Branch Profit Tax Treaty is the Lex specialist of the PSC.
1. First Tranche Petroleum (FTP) and Cost recovery
First Tranche Petroleum (FTP) is the oil and gas shared by the parties in PSC before the cost recovery. Usually the FTP shared is between 10% – 20% of production. The FTP mechanism was applied for the first time in 1988 for Indonesian PSC, and for some oil and gas practitioners, FTP is treated as Quasi-Royalty.
Cost recovery is needed by the contractor to recover the costs of exploration, development and operations out of gross revenue. It is one of the most common features in PSC.
Taxable income in PSC is derived from the net revenue, which is already deducted from the FTP and cost recovery. Similar to the PSC system, in the concession system, taxable income is derived from net revenue which is already deducted from operating costs, depreciation, depletion and amortization (DD&A) and intangible drilling costs (IDCs). These deductions in the concession system can be counted as cost recovery, but the difference with cost recovery in PSC that there is ‘no cost recovery limit’ in the concession system.[1] In the Indonesian PSC system, cost recovery submitted by oil companies is audited by the State Audit Board (BPK) and/or Agency for Finance and Development Supervision (BPKP) and also the Upstream Oil and Gas Supervisory Board (BP MIGAS).
2. Different income tax regulations for different PSC generations
2.1 PSCs signed before the enactment of Income Tax Act 1983
PSCs signed before the enactment of Law No. 7 of 1983, regarding Income Tax (Income Tax Act 1983), are subject to Corporate Tax Ordonantie 1925 and Tax upon Interest, Dividend, and Royalty Act 1970 with all the implementing regulations. Moreover, Minister of Finance Decree No. 267/KMK.012/1978 (KMK 267) also regulates the double layer of taxation which will be further discussed below.
2.2 PSCs signed after the enactment of the Income Tax Act 1983
All the PSCs signed after the enactment of Income Tax Act 1983 are subject to Income Tax Act 1983 and its amendments, consequently by Law No. 7 of 1991, Law No. 10 of 1994 and Law No. 17 of 2000 (Income Tax Acts). Other than that, Minister of Finance Decree No. 458/KMK.012/1984 (KMK 458) is also applicable to the PSCs.
3. Double layer of taxation
The Income Tax Acts uses a mechanism known as effective tax rate which is derived from Branch Profit Tax levied after Corporate Income Tax. Branch Profit Tax, provided in Article 26 (4) of the Income Tax Acts, is an additional income tax upon the net income after tax received by a Permanent Establishment (Badan Usaha Tetap).[2] The normal rate for the Branch Profit Tax in the Income Tax Acts is 20% after the Corporate Income Tax. However, for some countries which have a Branch Profit Tax Treaty with Indonesia, the Branch Profit Tax is below 20%.
In practice, the normal total effective tax rate which is payable by the oil companies/contractors after being deducted by the FTP and the Cost Oil is 44% of the oil companies’/contractors’ share.
[1] It is also must be noted that some other PSCs have no limit on cost recovery either.
[2] The Branch Profit Tax is regulated under Law No. 7 of 1983, regarding Income Tax as amended several times consequently by Law No. 7 of 1991, Law No. 10 of 1994 and Law No. 17 of 2000 (Income Tax Law), Article 26 (4). For PSCs signed before the Income Tax Law, Branch Profit Tax is also regulated under Minister of Finance Decree No. 267/KMK.012/1978 (KMK 267).
